EFTA01071011.pdf

THE DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT How the regulatory environment for derivatives is changing J.P.Morgan EFTA01071011  Glossary WHAT IS THE DODD-FRANK ACT? Swap Execution Facility (SEF): A facility. trading system or platform The Dodd-Frank Wall Street Reform and Consumer Protection Act ("the Dodd-Frank in which multiple participants have the Act- or "the Act") was passed following the financial crisis of 2OO8. The Act is broad ability to execute or trade swaps by legislation impacting several areas of the financial services industry. including certain accepting bids and offers made by parts of the Over-the.Counter (OTC) derivatives and Foreign Exchange (FX) markets. other participants. Derivatives Clearing Organization I A WORK IN PROGRESS (DCO): Also known as a CCP. The Act includes a number of new rules and regulations. some of which are A clearinghouse that is registered with already in force. while others have yet to be phased in. Full implementation and regulated by the U.S. Commodities Futures Trading Commission (CFTC). will be accomplished gradually over the next few years. and the regulations may evolve as they are implemented. Central Counter Party (CCP): Also known as -Central Clearing.' the CCP ll While this booklet sets out the main requirements of the regulations, these are interposes itself between every buyer subject to change. We aim to keep you fully up-to-date at every stage, and we and seller. It streamlines and simplifies are working hard to streamline the way our clients trade the affected products. post-execution trade processing, sets trade margin requirements. ensures For your reference. we have included definitions of some of the terms you may margin requirements are met and encounter. accounts are properly settled. Any derivatives trade transacted by a CCP is deemed -cleared." HOW WILL DODD-FRANK IMPACT OTC DERIVATIVES? Swap Data Repository (SDR): The Dodd-Frank Act covering OTC derivatives and FX products significantly changes how these This is a new entity created by the instruments will be traded. These changes are intended to: Dodd-Frank Act in order to provide a central facility for swap data reporting ■ Regulate the market to improve transparency and efficiency and recordkeeping. ■ Reduce credit and settlement risk for buyers and sellers ■ Reduce some of the systemic risks in the United States (U.S.) banking system All parties trading OTC derivatives and certain FX products in the U.S. will be impacted by the new regulations.' Execution. Certain trades will eventually be executed on an exchange or an electronic platform •:ne,:ci is a Swap Execution Facility (SEF). Clearing. All parties. except those who are 'commercial end users' or who enter into -bespoke- trades. will be required to clear certain trades. Trades requiring mandatory clearing will go through a Derivatives Clearing Organization (DCO), also known as a Central Counter Party (CCP). Effective dates for the clearing requirement will be phased in by product and type of market participant. While not finalized as of the date of this publication. we anticipate that mandatory clearing will start in March 2013 for Interest Rate Swaps (IRS) and Credit Default Swaps (CDS). Margin and collateral. For cleared trades. clients will need to post margin and collateral to a CCP instead of to 1.P. Morgan. Reporting. Trades in the products impacted by the Act must be reported to a central Swap Data Repository (SDR) on a timely basis. ' Clients outside the U.S. may be impacted by some of the regulations. we will contact such clients separately as the rules are finalized. 1 EFTA01071012 Glossary WHICH DERIVATIVES TRANSACTIONS 2. Uncleared: In addition to those transactions WILL BE AFFECTED? entered into by 'commercial end users." Executing Broker (EB): A trading J.P. Morgan anticipates that certain complex member that executes trades on behalf various trades will be impacted. These include: or illiquid derivatives transactions will of its clients. Many Executing Brokers ■ Swaps continue to trade over-the-counter. are themselves Clearing Brokers. known Certain "bespoke' transactions also will as "self-clearing." J.P. Morgan is an ■ FX, Commodity and Fixed Income Options be uncleared. Executing Broker for OTC derivatives ■ Forwards' and FX transactions. 3. Exempt: Some products or transactions EXECUTION AND CLEARING: are exempt from the new regulations: Clearing Broker (CB): Also known as a for example, structured notes. most HOW WILL THE PROCESS CHANGE? Clearing Agent. A clearing house member equity options, and FX and commodity that can clear its own proprietary trades, How will products be executed? spot transactions. client trades (as agent or riskless It is anticipated that SEFs will be established Note: Legacy transactions (any OTC derivatives principal). and/or trades executed by to execute cleared transactions. Until then. transactions that you entered into prior to the other trading members. financial institutions acting as Executing effective date of the provisions) are exempt from Brokers will execute these transactions. the majority of the new Dodd-Frank requirements. Futures Commission Merchant (FCM): All Clearing Brokers are required to be but will be subject to the transaction reporting How will products be cleared? FChls. FCMs solicit or accept orders for requirements. Rollovers. however. will be subject The Dodd-Frank Act will classify OTC derivatives to all the requirements. the purchase or sale of any commodity for future delivery on. or subject to and FX transactions into three categories: In summary. clients will execute trades with the rules of. any exchange that accepts cleared. uncleared and exempt. an Executing Broker, clear through a Clearing payment from. or extends credit to. 1. Cleared: Most OTC derivatives will be Broker, and their collateral will be posted to a those whose orders are accepted. required to clear through a CCP. which will Central Counter Party. Morgan is a registered FCM. streamline post-execution trade processing. Clients can choose the Executing Broker. The CCP becomes the counter party between Clearing Broker and CCP they wish to use to every client and Clearing Broker for the transact derivatives. cleared transactions. and also will hold all collateral posted by clients. A Futures Morgan is able to act as an Executing Commission Merchant (FCM) will act as a Broker for OTC derivatives and FX transactions. Clearing Broker and will interact with the CCP. and the firm is also a registered ECM, enabling it to act as a Clearing Broker. J.P. Morgan All products within scope that the CFTC has will have separate teams to handle your mandated to be cleared will need to be derivatives execution and clearing needs. cleared. Plain vanilla products such as CDS and IRS will be the first products required to be cleared by the legislation. followed by other products. 2 EFTA01071013 DODD-FRANK MODEL OF TRADE CLEARING General Definitions The diagram below shows the new trade execution and clearing process for J.P. Morgan U.S. Commodity Futures Trading clients. One key change from the current process is the role of the CCP. With these new Commission (CFTC): The U.S. Congress requirements. a CCP sits between every buyer and seller, streamlining and simplifying created the U.S. Commodity Futures post-execution trade processing. Trading Commission (CFTC) in 1974 as an independent agency to regulate commodity futures and option markets in the U.S. The agency's mandate has Clearing been renewed and expanded several Bioko (C8) times since then. most recently by the Executing or Futures Bi okui (EB) Commission Dodd-Frank Wall Street Reform and Consumer Protection Act. (FM' LCH Clearnet Limited (LCH): This organization operates the SkvapClear J.P. MORGAN service. It is regulated as a CCP by the CFTC. and recognized as a clearinghouse by the U.K. Financial Services Authority (FSA). LCH clears a broad range of OTC and exchange-traded cash and derivatives U.P. MORGAN: A RECOGNIZED LEADER IN OTC CLEARING products. and is the largest global clearer Under the new legislation. clients are able to choose a Clearing Broker. In making this choice. of OTC markets. clearing for major clients should consider various criteria. including risk management capabilities: we believe international trading platforms and there are a number of compelling reasons to continue your relationship with us. exchanges. It is owned 83% by users and 17% by exchanges. 1.P. Morgan is a recognized leader in OTC clearing, and was named OTC Clearing Service of the Year in 2012 by Risk magazine in its Risk awards. The firm provides clearing services Intercontinental Exchange (ICE): through J.P. Morgan Securities LLC (1PMS). which is rated A« by both Standard & Poor's Established in 2000. ICE is a leading and Fitch Ratings. operator of integrated OTC and futures Risk management is of paramount importance in clearing. as in all of our other lines of markets. offering clearing. processing business. We have dedicated teams managing the contingent market risk of each clearing and data services for global derivatives client's portfolio on an intraday and real-time basis. markets. It is the global leader in OTC ■ We can offer our clients operational readiness, with continued investment in technology energy and credit markets. as well as listed derivatives in energy. agriculture. ■ we are a top-tier futures and options broker. with 30 years of experience in providing equity indexes and foreign exchange. our clients with research. sales. execution and clearing services ICE has five clearinghouses for OTC ■ we have cleared interdealer interest rate swaps to LCH since 2001 and have supported markets and listed derivatives in the LCII. ICE and CME client clearing platforms since their respective launches O.S.. Europe and Canada. CME Group (CME): CME is one of the world's largest futures exchanges and most diverse derivatives marketplaces. formed after the Chicago Mercantile Exchange and the Chicago Board of Trade merged in 2007. The exchange focuses on four major sections. including commodities. FX. interest rates and stock indexes. It provides a wide range of benchmark futures and options products. 'Will occur with I.P. Morgan Private Bank or J.P. Morgan Securities. covering all major asset classes. Clients can choose the Executing Broker. Clearing Broker and CCP they wish to use to transact derivatives. 3 EFTA01071014 Glossary MARGIN AND COLLATERAL Initial Margin (IM): The percentage of How will the process change? the purchase price of securities (that can be purchased on margin) that investors The Dodd-Frank Act will have a broad impact on the margin and collateral process for OTC must pay for with their own cash or derivatives and FX transactions. Namely: marginable securities. Customers' funds ■ Clients must meet daily margin requirements by posting margin. The margin requirements are offered as security for a guarantee are tightly defined under the Act and include only cash and certain cash equivalents. such as of contract fulfillment at the time a U.S. Treasury and U.S. Agency debt obligations. 1.P. Morgan will require cash. and expects market position is established. to include cash equivalents as acceptable collateral in the future ■ All OTC derivatives transactions subject to the Act will be segregated by the firm in a separate Variation Margin (VM): Payment made derivatives account of the client to facilitate the margining process. Within the derivatives on a daily basis by a clearing member to account. cleared and uncleared transactions also will be segregated the Central Clearing organization. based on adverse price movement in positions ■ Margin requirements will be computed daily, including an initial margin and variation margin. carried by the clearing member. based on the daily mark-to-market value of outstanding positions calculated separately for customer ■ These requirements will be set by J.P. Morgan Private Bank and .I.P. Morgan Securities. One of and proprietary positions. the factors in determining the margin requirements will be the minimum requirements set by the CCP ((or cleared transactions). and the regulations (for uncleared transactions) In its role as Clearing Broker..i.P. Morgan will be required to post margin to the CCP on a daily basis on behalf of clients. As a result, margin will be held at the CCP instead of at J.P. Morgan. For J.P. Morgan to facilitate the daily movement of collateral. clients will need to provide standing instructions. In addition. Uniform Commercial Code (UCC) filings will be made. Central Counter Party Clients will be able to choose the CCP they wish to use. There are many CCPs operating in the market. including CME. Options Clearing Corporation. EUREX. DTCC. LCH and ICE. For CDS and IRS. three of these CCPs—LCH Clearnet Limited (LCH). Intercontinental Exchange (ICE) and CME Group (CME)—will be available for J.P. Morgan Private Bank and J.P. Morgan Securities clients to clear trades in March 2O13. when the new regulations are expected to become effective. The list of CCPs may change over time as the industry matures. J.P. MORGAN'S ROLE IN EVALUATING CCPs J.P. Morgan uses its extensive network and considerable global resources to evaluate CCPs. assessing them on a number of criteria. and only including those that reach our high standards. We look for excellence in the following areas: Risk management Default management Operational capabilities Margin calculation Protection afforded by Ability to clear/register methodology loss waterfall trades in real time Frequency of intraday calls Segregation of initial margin Ability to process products Liquidity of eligible Well-defined, documented Trade event processing collateral and tested process (for example. coupons. credit events. non-deliverable Guaranty fund-size and Timing and conditions of forward fixings. option apportion among members the CCP guaranteed to be exercises) in force EFTA01071015 COMPLYING WITH DODD-FRANK: SUITABILITY REQUIREMENTS AND TRADE REPORTING In addition to the changed procedures. clients who wish to trade OTC derivatives and FX must meet certain suitability criteria and sign new documentation. Eligible Contract Participants (ECPs) Dodd-Frank requires clients engaging in certain OTC derivatives and FX trades to confirm their eligibility to trade these products by certifying as Eligible Contract Participants (ECPs). The main ECP criteria are as follows: ■ An individual acting for his or her own account who has amounts invested on a discretionary basis. the aggregate of which is in excess of (i) $10 million: or (ii) $5 million. and who enters into transactions in order to manage the risk associated with an asset owned or liability incurred. or reasonably likely to be owned or incurred. by the individual ■ A corporation. partnership. proprietorship. organization. trust or other entity acting for its own account: (i) that has total assets exceeding $10 million (ii) that (a) has a net worth exceeding $1 million: and (b) enters into transactions in connection with the conduct of an entity's business or to manage the risk associated with an asset or liability owned or incurred. or reasonably likely to be owned or incurred, by the entity in the conduct of the entity's business Legal Entity Identifiers (LEls) The Act requires legal entities (not individuals) who want to trade certain OTC derivatives products to obtain an identification number known as a Legal Entity Identifier (LEI), starting in late 2012. This will allow regulatory bodies to globally track market activity and financial risk in connection with transactions. Until a global LEI system is established. the U.S. Commodity Futures Trading Commission (CFTC) is requiring a CFTC Interim Compliant Identifier. or CICI. This unique 20-character. alpha-numeric code •mill be attached to cer lain derivatives trades that will be reported to regulators. Reporting of OTC transaction data to Swap Data Repositories In an effort to increase transparency. Dodd-Frank regulations require information about derivatives transactions to be sent to a central Swap Data Repository registered with the regulators. 5 EFTA01071016 Keeping you informed As the Dodd-Frank legislation progresses NEW DOCUMENTS REQUIRED TO CON 1 I NUE TO TRADE and evolves. we are committed to always DERIVATIVES PRODUCTS keeping you fully informed. If you would The new regulatory environment requires a different set of documents that you may need like to find out more about the Act. you to read and/or sign to continue to trade derivatives products. Details are given below. can visit: Forms you need to review, sign and return to us The U.S. Commodity Futures Trading Commission website Bilateral Agreement. This supplements the terms and disclosure provisions governing your trading relationship with us. and is an agreement to comply with Dodd-Frank regulations. http:/Avww.citc.govilawregulation/ doddfrankact/index.htm Client (Futures) Agreement. This agreement sets out the terms and conditions that or will apply if you want to trade cleared derivatives transactions using 1.P. Morgan as the The SEC website Executing Broker and Clearing Broker. htip://www.sec.govispotlight/ OTC Addendum. This includes additional terms and conditions that will apply if you dodd-frank.shtml want to trade cleared derivatives transactions with us. Your 1.P. Morgan representative will be The Client (Futures) Agreement and the OTC Addendum contain terms and conditions that happy to work with you to enable you will apply to all cleared trades you enter into. and allows J.P. Morgan to be a designated to continue to trade derivatives with clearing member for you. 1.P. Morgan under the new regulations. Derivatives Account Application and Agreement: Swaps and Other Contracts. This form provides the basis for 1.P. Morgan to transact on your behalf with SEFs and CCPs. and confirms your eligibility for derivatives trades under the new rules. Standing Instructions Form. This form will allow 1.P. Morgan to move cash balances from your designated account(s) to meet margin requirements. FIA-ISDA Cleared Derivatives Execution Agreement. This outlines the terms and conditions if trades tail to clear. Regulation T Account Opening Form. This allows you to establish a Reg. T lending facility. enabling you to borrow cash to meet each margin call. subject to credit approval. If you would like 1.P. Morgan to draw on your Reg. T lending facility to meet derivatives margin calls. please select the appropriate options in the Standing Instructions Form. 1.P. Morgan Private Bank' is the marketing name for the private banking business conducted by 1Phlorgan Chase & Co. and its subsidiaries worldwide. In the United Kingdom. this material is approved for issue by I.P. Morgan international Bank Limited (JPMIB). authorized and regulated by the Financial Services Authority. in addition. this material may be distributed by: iPlAorgan Chase Bank. N.A. Paris branch. which is regulated by the French banking authorities Aurorae de Contitle Prudentiel and Autorite des Marches Financiers: J.P. Morgan (Suisse) SA. regulated by the Swiss Financial Market Supervisory Authority: IPhlorgan Chase Bank. N.A. Bahrain branch, licensed as a conventional wholesale bank by the Central Bank of Bahrain (for professional clients only): Whlorgan Chase Bank. N.A. Dubai branch. regulated by the Dubai Financial Services Authority (for professional clients only). in Hong Kong. this material is distributed by WMorgan Chase Bank. N.A. (JPMCB) Hong Kong branch except to recipients having an account at JPMCB Singapore branch and where this material relates to a Collective investment Scheme (other than private funds such as private equity and hedge funds), in which case it is distributed by J.P. Morgan Securities (Asia Pacific) Limited (JPMSAPL). Both JPMCB Hong Kong branch and JPIASAPL are regulated by the Hong Kong Monetary Authority. In Singapore, this material is distributed by IPMCB Singapore branch except to recipients having an account at JPMCB Singapore branch and where this material relates to a Collective Investment Scheme (other than private funds such as private equity and hedge funds). in which case it is distributed by LP. Morgan (S.E.A.) Limited (JPMSEAL). Both JPMCB Singapore branch and JP&ISEAL are regulated by the Monetary Authority of Singapore. If you no longer wish to receive these communications, please contact your usual I.P. Morgan representative. J.P. Morgan Securities offers investment products and services through LP. Morgan Securities, LLC. Member NYSE, FINRA and SIPC. D2012 Whlorgan Chase & Co. All rights reserved. EFTA01071017 0912-057-IN 1012-0592-02 EFTA01071018